Free Tax Ride May Be Over On Pension Abuse

JANE BRYANT QUINN Staying Ahead

October 29, 1995|JANE BRYANT QUINN

Do you own a small company? Or are you self-employed? To tax-deduct your retirement contributions, you might want to set up a Simplified Employee Pension plan. It comes with a bonus: zero government paperwork or oversight.

No one knows how many such plans exist or how much money is stashed away. What's more, no one knows what percentage of pension plan holders actually obey the rules.

Pension administrators say that plenty of SEP-holders are tax-deducting extra money illegally. But because they don't have to file reports, the government cannot find out. If the Congress expands SEP plans, as it currently intends, "they'll create a monster, because they can't control the abuses," says G. Patrick Byrnes, president of Actuarial Consultants in Torrance, Calif.

SEPs are a type of individual retirement account, but with larger contributions. Normal IRAs let you tax defer up to $2,000 a year; SEP IRAs can accept as much as 15 percent of salary, with an annual contribution limit of $22,500.

Mistakes go unnoticed

The rules include a 10 percent penalty for withdrawals before age 59 1/2; mandatory withdrawals starting at age 70 1/2; and a prohibition against taking loans against the plan.

But these "simplified" plans aren't as simple as they sound. Many who have them accidentally misread the rules, and because you don't file annual reports, no one is likely to catch your mistakes.

In some cases, people ignore the rules deliberately. They might contribute (and tax defer) extra money every year, fail to pay the penalty on early withdrawals or leave all their money in the plan even after age 701/2. A company's simplified plan might illegally cover only the owner, leaving out employees.

Some small companies use SEPs as an annual bonus plan. They make tax-deductible contributions for their workers, then tell the workers that they're free to withdraw the money. Result: The company gets a tax deduction, the worker gets some current cash and the U.S. Treasury loses out. By disguising the bonuses as SEP contributions, owners also get to add more to the SEP plan for themselves.

The IRS knows there's a problem here. Next year's tax forms will have a box to check if you're deducting for an SEP. A sample of these returns will be examined, "so we can find out more," says Evelyn Petschek, director of the IRS' Employee Plans Division. Audit guidelines will also be developed for examiners in the field.

Expert advice can help

So be warned: If you're misusing your SEP, your free ride may not last forever. For a free brochure on SEPs, call 1-800-TAX-FORM; ask for publication 560.

If you're thinking of setting up a Simplified Employee Pension plan, here are some rules to keep in mind:

-- They are truly simple for one-person businesses - better than Keogh plans, which require filing annual reports. You can contribute and tax-deduct up to 13.04 percent of your self-employment earnings, with a maximum contribution of $22,500 a year.

-- SEPs, Keoghs and other plans get more complicated for people who have employees. And because you normally set up SEPs through mutual funds, stockbrokers or insurance agents, you may not get the expert advice you need to make the proper choice. It pays to hire an expert. For example, while business owners can put up to 15 percent of salary into SEPs for employees, their own limit is 13.04 percent of self-employment earnings. You might rather start a 401(k).